US-China Trade Truce: Don't Count Your Chickens Yet

Markets
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Global markets thought they were getting an early Christmas present at the start of December when China and the US have agreed to halt new trade tariffs for 90 days. But as subsequent developments have shown, the US-China trade sage is far from over and it will be wise to remain prudent as volatility is likely to persist in 2019.

Following the landmark Trump-Xi meeting in Buenos Aires over the weekend, the US released a statement regarding the temporary truce and how it will be continuing negotiations with China in terms of coming to an agreement over their trade differences.

No early gifts for the markets from the US-China trade truce. Photocredit: Getty

Getty

Given how the US-China trade dispute has been a key drag on global markets this year, the investment community unsurprisingly took to the development with open arms. Most global indices soared on the first trading day of December, with some commentators even proclaiming the end of the trade dispute – words that have since been proven to be spoken too early, too soon.

Only a few days into the trade truce, news broke that the Chief Financial Officer of a leading Chinese corporate has been arrested in Canada and could be extradited to the US on charges for violating US sanctions against Iran. The arrest created an uproar in China and sent shockwaves throughout the investment community given the prominence of the company involved and the timing of the arrest.

Consequently, markets fell and erased any momentum gained from the landmark Trump-Xi meeting in Buenos Aires. While the person under detention has since been released on bail, global markets remain muted.

Fundamental differences

There is no denying that the trade truce is a step in the right direction heading into 2019, but it is important for investors to remain grounded and not overindulge in the positivity. After all, the US and China have already had a number of trade discussions over the past few years many of which have very little to show for.

While China has recently resumed the purchase of American soybeans, the Chinese has always maintained that they will only be making the necessary changes and reforms if it does not compromise the health of its domestic economy or the needs of its population.

Many of the changes the US is pushing China to make are to the long-term benefit of China although it remains to be seen just how the two sides can come to a compromise over a number of complicated issues. This includes forced technology transfer, intellectual property protection, non-tariff barriers and cybersecurity.

The next 90 days should probably provide us with more clarity, but until that happens, nothing has changed. The trade dispute might be halted, but it has not ended. And as the recent detention of the Chinese CFO has shown, volatility is still very much around us.

The next 90 days should provide markets with some much needed direction. Photocredit: Getty

Getty

To further complicate matters, the US has warned that it could still go ahead with the 25% tariff increase if no deal is struck at the end of 90 days. Add everything together and investors face a delicate and complex scenario that could easily go one way or the other.

Cautiously optimistic

On a macro level, the Chinese economy is continuing to moderate. The official NBS Manufacturing PMI dipping to 50* in November, down from 50.2 a month earlier and is also the lowest level since July 2016. Additionally, the effects of the current tariffs will likely be felt in the coming quarters, which would put substantial pressure on headline growth and its current account.

Source: National Bureau of Statistics of China

Still, there is no need to be overly negative on China as the authorities have shown over the course of the past few months its willingness to step up supportive policies as and when they are needed. This includes accelerating spending on infrastructure, easing monetary policies to increase lending to small and medium-sized firms as well as income breaks to boost consumption.

Domestic consumption, in particular, is going to be the country’s key growth story in the coming years, as it continues its transformation away from being a manufacturing and export-oriented powerhouse. Online retail giant Alibaba, for example, experienced a record US$30.8 billion of Singles’ Day sales this year, which is not only a 27% jump over 2017, but also higher than what most countries are able to sell online in a single year. The sheer size and potential of the domestic Chinese market is for all to see.

It is also important to point out that the divergence between the US, Emerging Market and China in terms of equity valuations is currently one of the widest in history. This indicates that Asian markets are dislocated compared to Developed Markets.

To put things into perspective, the MSCI AC Asia ex-Japan Index is trading at a 12-month forward PE of 11.2x^, while the MSCI China Index stands at around 10.6x forward PE. Both are on the low side of their historical averages and significantly cheaper than the MSCI World Index (14.5x forward PE). While valuations are attractive, it is important for investors to remain nimble, as we await for the situation to unfold amidst the 90-day trade truce.

* Source: National Bureau of Statistics of China

^ Source: MSCI

Disclaimer: The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All materials have been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.